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The golden age of television

Viewers and advertisers are the winners as legacy broadcasters fight back against the onslaught of the media insurgents led by Netflix and Amazon.

It’s easy to observe the march of the revolutionary forces rampaging through the television industry. Just stand and watch people on a train, in a doctor’s surgery or ticket queue. Ten to 15 years ago, they might have been reading a newspaper, talking to someone else or staring into space. Now most, if not all, will be glued to their mobile phones or tablets.

Some will be texting or reading emails, but an increasing number will be watching their favourite TV show. For while once people simply watched TV at home, viewers can now use subscription video-on-demand (SVOD) services, such as those offered by Netflix, to access programmes. They can choose content when they want rather than having to watch at a specific broadcast time. Moreover, they can do so via a wide variety of devices, from mobile phones to laptops and tablets. This development, and the ability to download or stream programmes, lets viewers watch TV anywhere and at anytime.

The arrival of internet-based TV service providers has boosted the range and the quality of content. To attract viewers, the insurgents are investing heavily in new programming, forcing the legacy broadcasters to follow suit in a bid to retain viewers.

“Advertisers, media makers and distributors, are being forced to adapt to the consumers’ advantage,” says Jason Bohnet, Senior Securities Analyst at Aviva Investors in Chicago. “We are seeing a pivot towards the likes of Netflix, Amazon Prime, Hulu, DIRECTV NOW and other internet-based services throughout the developed countries, a trend that is allowing the consumer to pick and choose what they pay for and watch.”

Power shifts

Competition from well-capitalised internet-base providers is overturning established business models; with traditional suppliers of multi-channel, pay-TV services, known as linear TV, under pressure. In the US, cable companies are suffering from the phenomenon of cord cutting, where viewers cancel their subscriptions and sign up to cheaper rival services from the likes of Amazon and Netflix.

The 11 largest pay-TV providers in the US, representing about 95 per cent of the market, lost 255,000 net subscribers in the third quarter of 2016, compared to a loss of 210,000 subscribers in the same period in 2015 according to Leichtman Research Group, a consultancy. Over the year, the top pay-TV providers lost 755,000 subscribers, compared to a loss of 445,000 over the prior year1.

Viewers are not simply cancelling subscriptions; they are downsizing their cable deals. Americans tend to purchase cable via a bundled system, which includes a vast amount of channels they never watch.

“Cable companies spend a significant amount broadcasting sport events and pass these costs on to the consumer whether they want to watch the events or not,” says Bohnet. Consequently, consumers are now being offered 'skinny bundles', i.e., subscription packages with fewer channels, for a significantly lower price than the total package.

That trend is having a dramatic impact on the cable operators’ revenues and earnings, with some smaller operators particularly badly hit. In January 2017, NBC Universal’s Esquire Network said it would close its linear cable TV channel and convert to a digital channel2.That could be a route other cable channels follow.

The advantages of internet-based services are clear. The mean monthly spend on pay-TV in the US in September 2016 amounted to US$103.10, an increase of four per cent over the previous year but the lowest annual increase in five years, according to Leichtman3. By contrast, the Standard Netflix plan, which gives buyers the ability to use Netflix on two screens at once, costs $9.99 a month, while Amazon Prime costs $99 per year or $10.99 per month.

Unlike most cable companies, streaming services offer the ability to sign up and cancel without termination fees. Netflix has further boosted its appeal by innovations such as “binge-viewing”, involving the release of an entire series at once. Legacy broadcasters such as the BBC are following suit. Netflix also uses the content a viewer watches to recommend similar TV shows and movies. It is hard to argue with Netflix’s contention that the ability to watch live sport is the only real reason a viewer would prefer to keep a traditional cable or satellite subscription.

Netflix signed up a record 7.05 million customers in the final quarter of 2016, and added 19 million subscribers worldwide during the year. It now has 93 million customers in 190 countries. During 2016, the company generated revenue of US$8.8 billion, 30 per cent up on the previous year, and profits of US$186.7 million, up from US$122.6 million in 2015. Netflix forecasts earnings of US$165 million, or 37 cents a share, for the first quarter of 2017, which would mark the company’s biggest profit ever. Netflix has tapped the bond market to fund its content/growth strategy, and is expected to return to the credit market in 2017. Having begun commissioning original content in 2013, it is investing US$6 billion in 1,000 hours of original programming in 2017, having spent around US$5 billion on 600 hours last year4. Thus, it no longer relies solely on its vast library to attract subscribers.

A virtuous circle

The new programming boosts its appeal to subscribers, which creates even more revenues to develop 'Netflix Originals',“a term you could argue has become synonymous with quality”, according to the BBC5. So viewers benefit not just from lower fees to watch TV but also enjoy higher quality content. Indeed, the BBC has said it “cannot win” against the financial firepower deployed by Netflix and Amazon. It aims to become a “lighter, simpler” organisation, and is co-producing a number of series with Netflix5.

Amazon also poses an increasingly potent threat to the legacy broadcasters. Launched in 2007, it offers unlimited access to a bank of movies, films, music and e-books for a fixed monthly fee. Amazon, too, spends billions of dollars on original content designed to drive consumers to its Prime package and keep them on the Amazon platform, where they can buy a host of other products.

“Amazon has a different business model from Netflix in that Amazon seeks to attract and keep people within its ecosystem. Providing content is almost a cost of doing business,” says Bohnet.

A sweet spot for advertisers

The sheer amount of content available to the viewing public, both through set-top boxes and digital channels, as well as the information gathered by the broadcasters on their viewers, is also having a dramatic impact on the advertising industry.

The old adage “50 per cent of my advertising is effective, I just don't know which 50 per cent” no longer rings true, according to Tony Gilliland, Senior Securities Analyst, Aviva Investors.

Improvements in software and data quality enable highly-focused advertising. An insurance firm can, for example, target people whose insurance is about to expire. “Facebook, which is increasingly broadcasting videos, can tell potential advertisers it has the ability to target a particular demographic even down to a zip code, an age group and an individual who is in the market for a particular product or service because it has the data, much of it supplied voluntarily by users,” says Gilliland.

The use of targeting has attracted brands that have not traditionally been on TV, particularly those focused on a region or locality. Meanwhile, the customer experience also improves since the adverts become more relevant to individual users. That is important given many people find advertising intrusive and, as Netflix has found, are willing to pay to avoid it.

Traditionally, distributors and content producers were paid in relation to the number of viewers the content attracted. The Super Bowl, for example, can command fees of five million dollars per commercial because it attracts over 100 million people.

The number of people watching the event could be recorded simply at the time it was broadcast. But nowadays people stream or download programmes and watch them at a later date. Or, rather than watching a TV series as each episode is broadcast, viewers will binge on an entire series in a weekend.

Adverts are no longer measured on how many people watch at the time of broadcast but up to 30 days afterwards. Adverts are also changing or being pulled after a show is first shown. For example, if an advertiser holds a sale on the weekend an event is broadcast, the advert can be replaced by an ad for another brand to target viewers who have downloaded the programme and are watching it at a later date.

“In the past, an advertising agency tasked with promoting, for example, a product aimed at 30-year old men would simply choose a programme watched by large numbers of young men, such as a football match,” says Trevor Green, Head of UK Equities, Aviva Investors. “Now, the agency will conduct a social media campaign and run adverts on mobile phones as well. Some companies such as Red Bull even eschew traditional TV advertising and focus solely on social media with great success.” Red Bull’s videos featuring mountain bike champion Danny MacAskill, for example, attract tens of millions of viewers.

The Empire strikes back

The ability of traditional distributors such as US cable companies to survive the onslaught from the internet-based TV businesses depends on their ability to offer high-quality content and satisfy the needs of advertisers, says Gilliland. The cable companies are adopting various strategies to achieve this goal, including through Hulu, an online SVOD platform that launched to the public in 2008.

It is owned by giant established media conglomerates that also have cable interests, including Disney, Comcast, Twenty-First Century Fox and Time Warner. Hulu can draw on a huge library from its owners, including successful programmes from the 1990s and 2000s, which can now generate fresh revenues. It, too, is commissioning original programming and, along with Netflix and Amazon, is among the top three internet-based TV providers in the US.

The cable companies are also offering their own streaming services. Comcast, the largest cable provider in the US with over 22 million subscribers6, moved into the over-the-top video delivery market in 2016 with the launch of its Internet TV service called "Stream". The company has also moved to integrate Netflix's content directly from its set-top box.

In the UK, the main commercial broadcaster ITV has reacted to the digital threat by building up its online content, says Green, via the ITV Hub, an online VOD service that can be accessed on mobile phones, PC and connected TVs. The Hub is available on over 27 platforms including ITV’s website (itv.com) and pay providers such as Virgin and Sky, or through direct content deals with services such as Amazon, Apple iTunes and Netflix7.

“ITV is also investing heavily in new content via its Studios division with the aim of reducing its dependency on income from advertising,” says Green. This strategy appears to be paying off, with revenue at ITV Studios rising by 31 per cent to £651 million in the six months to 30 June 20168. The company added that ITV Studios was on track to deliver double-digit total revenue and adjusted EBITA growth over the full year, primarily driven by acquisitions.

In December 2016, ITV joined forces with BBC Worldwide, the commercial arm of the BBC, in a joint venture called BritBox, an ad-free SVOD service, which will launch in the US during the first quarter of 2017. The launch is reportedly a prelude to the introduction of a joint subscription service in the UK. Reportedly, BritBox will not replace either the BBC iPlayer or ITV Player services and will primarily attract viewers who wish to watch content that has moved out of the 30-day catch-up window of iPlayer and ITV Player9.

Bid rumours have been swirling around ITV for some time, reflecting the valuable content it owns says Green. Potential bidders include major technology companies such as Apple and Google, and global broadcasting rivals such as Netflix and the major US cable companies. The fall in the value of sterling since the Brexit vote has heightened its appeal to potential foreign suitors.

M&A

Many of the M&A deals in the media sector highlight the truth of Bill Gates’ adage that “content is king”. As Netflix is demonstrating, original content is the critical differentiator given the multitude of delivery platforms. However, as Green warns: “Good content is scarce and good content businesses very rarely come up for sale, but when they do you have to be careful not to overpay.”

In October 2016, AT&T announced plans to acquire media giant Time Warner for $109 billion, including net liabilities. AT&T is keen to distribute Time Warner’s entertainment content, from HBO shows, which include Game of Thrones, to Turner’s NBA basketball games, over its expansive network. AT&T has the world’s largest pay TV subscriber base and the ability to distribute this content across TV, mobile and broadband in the US, and mobile in Mexico and TV in Latin America10.

In August 2016, Comcast acquired Dreamworks, best known for its 'Shrek' and 'Kung Fu Panda' films, for $3.8 billion11. Comcast can exploit Dreamworks’ ability to produce original content for its TV channels and leverage Dreamworks’ character creations in its theme parks and consumer products business.

In terms of viewership, the shift from cable to online and increasingly to wireless has clearly created a problem for the distributors, namely the cable companies, who are losing their customers, says Gilliland. However, he adds “it brings advantages to the advertisers who want to go where the eyeballs are but also seek targeted advertising”.

When viewers access content online or via a wireless signal, the distributors of this content -namely the wireless carriers such as AT&T, Verizon and T-Mobile - can provide much greater insight into a customer and their purchasing patterns. That information is so valuable to advertisers they are prepared to pay to access it.

“The need for data that can forecast how consumers behave and what they like is now a key driver behind M&A in the media sector,” says Gilliland.

T-Mobile, majority owned by Deutsche Telekom, is one of the four big mobile carriers in the US and “is in the crosshairs of many would-be buyers as it has an asset people want, namely a mobile network with access to customers” adds Gilliland.

A slow decline?

It is too early to predict the death of linear TV given its long-time incumbency in the US says Bohnet, but he predicts that “it will continue to lose market share over time as other platforms come up with better value for customers”.

Bohnet says Netflix will soon have 110 million households subscribing to its service in the US, which is similar to the figures for pay-TV overall. However, he points out that “many consumers use Netflix as well as some type of traditional linear TV and while more and more people are watching SVOD services from the likes of Netflix, the cable companies remain hugely important.”

“The legacy broadcasters are seeking to re-position over the long-term, and they are not just going to melt away”, adds Bohnet.

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 8 February 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St Helen’s, 1 Undershaft, London EC3DQ. Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association.

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